April 1, 2025 • 24 mins
Many retirees focus on achieving a high Monte Carlo “probability of success” in retirement—but is chasing a 99% success rate always the best move? In this episode, James highlights a real-life story of a man forced to delay retirement after a divorce dropped his probability of success from 99% to 70%. James explores why this single number shouldn't drive such massive decisions. He explains how context—like income sources, spending flexibility, and home equity—matters more than a static success rate. You’ll learn why 100% isn’t always ideal, and how to build a retirement plan that supports a meaningful life, not just a perfect score.
Questions answered?
1. Should I delay retirement if my Monte Carlo probability of success drops?
2. Is a 100% probability of success the best goal for my retirement plan?
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Timestamps:
0:00 - An encounter at the gym
2:37 - What is Monte Carlo analysis?
4:18 - Consider severity of failure
6:19 - Consider other assets, like property
7:35 - Is a 100% probability score really success?
10:55 - Monitor and course correct
14:13 - Margin
15:07 - No universal number
16:13 - Assumptions about spending
18:27 - Retirement spending smile
20:57 - Context matters
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:02):
This is another episode of Ready for Retirement.
I'm your host, james Canole,and I'm here to teach you how to
get the most out of life withyour money.
And now on to the episode.
I was at the gym the other dayand someone came up to me who
recognized me from the YouTubechannel and he said hey, I
watched some of your videos andwe got to talking and he was
sharing with me how he had saveda whole bunch.
He and his wife had saved.
(00:24):
They've done really well intheir retirement portfolio.
They had a paid off home herelocally in a very nice part of
town.
He had a pension from work, hehad social security and they
were planning to retire.
And he shared that they had a99% plus probability of success
as they modeled this out withtheir financial advisor.
Then he went on to share withme that he and his wife actually
just went through a divorce andafter the divorce, after
(00:48):
splitting assets, aftereverything settled, his Monte
Carlo probability of successdropped to about 70%.
Now this individual he was 60years old and he was planning to
retire very soon until thedivorce happened, until this new
financial model showed that hisprobability of success dropped
from almost 100% probability ofsuccess to 70% probability of
success.
He then went on to share thatbecause of this change to his
financial situation specificallythis change to his probability
(01:10):
of success, given Monte Carlosimulations his new plan wasn't
to retire soon, but was actuallyto work another 10 years until
the age of 70, at which time hewould max out social security
and his probability of successwould be right back up there in
the high 90%.
Now I don't know any of thespecifics of this individual
situation.
I don't know dollar amounts, Idon't know desired retirement
lifestyle, I don't know what hewants to do in retirement.
(01:32):
I know none of that information.
I don't even know whether hisdecision to continue working
longer or not was good or bad,because I just don't know enough
information.
But what struck me about thisconversation was how many
enormous life decisions weremade, at least seemingly,
because of this single number,this single probability of
success number called a MonteCarlo analysis.
(01:53):
So what I don't know is I don'tknow that him working 10 years
longer after this was the rightdecision or the wrong decision
in light of previouscircumstances and what he just
went through.
But what I do know is thatthere's some deeper questions I
would have wanted to unpack if Iwas his financial advisor, to
say how can we be sure thedecisions you're making because
of this aren't going to cost youlong-term?
How can we properly look atwhat that Monte Carlo
(02:15):
probability of success numberlooks like in the context of a
bigger plan, in some seeminglysmall details or nuances that
could have dramatic impacts onall of this?
So what we're going to do todayis we're going to talk about
defining what exactly is thatMonte Carlo number and then how
should we view it?
And not just how should we viewit, but what are some common
things I see that can radicallychange that number upwards or
downwards that you all should beaware of.
(02:37):
So, as you're running yourplanning projections, you're
viewing things in the propercontext and you're not letting a
single number drive thedecisions you make or don't make
when it comes to something asimportant as when you retire and
what you do in your retirement.
I'm going to start by definingwhat exactly a Monte Carlo
number is, what that probabilityof success number means.
So when you have this number,this probability of success, it
(02:58):
is a randomly generatedsimulation using various
investment returns, inflationreturns, life expectancy numbers
.
All these things we cannotperfectly predict in advance
what the market's going to do,what inflation is going to do,
how long we're going to live.
And so when you randomlygenerate a whole bunch of
different scenarios, sayingbased upon the return
characteristics and the riskcharacteristics, something
(03:19):
called standard deviation ofinvestment returns, for example,
we can have a wide outcome interms of the possible scenarios
that we go through when weretire.
So it's not enough just to saywhat if you average a certain
rate of return throughoutretirement.
We need to know the sequence ofthose returns.
How would our probability ofsuccess change if we go into
retirement and have really pooryears the first few years versus
having really good years in themarket for those first few
(03:41):
years?
So this is a gauge that helpsus understand what is the
probability of success, akawhat's the probability of me
achieving my goals throughoutretirement.
Now that's the next thing that'simportant to know how do we
define success versus failure inthis?
This is really important andwhile it might seem simple
enough, I'm going to show you injust a bit some of the
downsides of viewing retirementthrough this lens.
(04:02):
But success simply means youhave lived your whole retirement
and you still have assets inyour portfolio or in the bank
when you die.
That's success.
You don't run out of money.
Failure, as defined by thesesimulations, is you run out of
money before you pass away.
So, very simple, very binary.
Those are the two definitionswe're looking at, and the
probability of success sayswhat's the probability that
(04:23):
you're going to have more moneyin your portfolio when you pass
away, versus the probability offailure is, of course, what's
the probability that you'regoing to run out of money, based
upon these simulations.
So let's now dive into it.
And again, I don't know thespecific numbers for this
individual, so this is notdesigned to be a specific
recommendation, of course, tohis plan, as much as pulling out
the principles that all of uscan be aware of when it comes to
our own planning.
Number one, and the first thingthat I want to point out, is
(04:45):
you do not need 99% or even 100%probability of success in order
to comfortably retire.
So what number is acceptable?
Well, this is where it depends,and what it depends upon is it
depends upon what is calledseverity of failure.
So, for example, thisindividual I was talking to I
don't know the numbers, but hementioned he has social security
and he has a pension.
(05:06):
Let me just assume somearbitrary numbers.
Let's assume that he wants tospend $10,000 per month in
retirement and let's also assumethat between social security
and his pension he has $9,000per month coming in, meaning his
portfolio is responsible forthe extra $1,000 per month.
Well, severity of failure heremeans what happens in some of
those instances that he does runout of money.
The severity of failure is notthat bad.
(05:28):
He takes a 10% pay cut.
Instead of spending $10,000 permonth, he's spending $9,000 per
month.
Not ideal, but if that's worstcase scenario, I'd be willing to
venture that most people wouldbe okay with that as their worst
case scenario.
Now let's compare that toanother scenario.
What if that pension and socialsecurity added up to $3,000 per
month and he wanted or neededto spend $10,000?
(05:49):
Well, now the severity offailure is a whole lot different
.
He has to take a 70% pay cut,goes from $10,000 per month of
living expenses down to $3,000.
So that's one thing that youneed to know.
To put this in proper context,it's not just what's the
probability of success, butwhat's the severity of failure.
If your severity of failure isnot that bad, you can afford to
(06:10):
go into retirement with a lowerprobability of success because
it's not going to be disaster,it's not going to be doom and
gloom if you actually were torun out of money, because you
have some other income sourcesthere to continue meeting your
needs, if your severity offailure is high, meaning you
could not continue living if youran out of money.
That's where you're going towant to have a higher
probability of success beforeyou go into your retirement
(06:31):
decisions.
Another thing that you want tolook at is, in this case I don't
know the value of thisindividual's home, but I know
where his home is and I knowthose homes are quite valuable,
quite nice.
So when you look at that,typically when you're running a
Monte Carlo simulation, you'rerunning a simulation that says
can these assets, can theseportfolio assets, last forever?
Because these portfolio assetsare my means of creating income.
(06:52):
And when I say last forever,what I should have said is can
these last for the rest of mylifetime?
Well, if you run out of moneyin your portfolio but you still
have a home, a lot of theseMonte Carlo simulations will
show that that's a failure, andit very well could be.
But you have to ask what areyou going to do with that home.
Let's assume that you'relooking at your plan and you
have a $2 million home, so anice home, well-valued home
today, and you don't intend toever sell your home if you don't
(07:14):
have to.
But we somehow fast forward 25years.
You're 60 today and at age 85,we know that you ran out of
money, because we have theability to predict the future.
Well, that $2 million home, ifit's been appreciating by 4% per
year, that $2 million home isworth closer to 5.3 million by
the time that you're 85.
So the Monte Carlo simulationwould say that's a failure
(07:36):
because it fails to recognizethat you've got a significant
piece of equity being your homeand now, no, you can't spend
your home.
But could you take a reversemortgage?
Could you downsize?
Could you do something elsewith it that allows you to
continue generating incomethroughout the remainder of your
plan?
So these are some things tolook at.
What's the severity of failureif you do in fact fail?
What other fallbacks do youhave if you do in fact quote,
(07:59):
unquote fail, given yourportfolio runs out, your home
could certainly be somethingthere.
I'm going to come back to thispoint in just a little bit, but
the next point that I want tomake is a 100% probability of
success, in my opinion,oftentimes is not actually
success.
This goes back to defining atthe very beginning what I talked
about.
If success means you have moneyin your portfolio when you die,
(08:19):
failure means you run out ofmoney before you die.
It's as simple as that.
To have a 100% probability ofsuccess in most cases means you
have such a significant buffer,you have such a significant
margin that no market downturn,no level of inflation, no,
anything has a serious chance ofderailing your ability to spend
what you want to spend.
(08:39):
Oftentimes you could translatethat to meaning you're only
taking a very small amount outof your portfolio.
For example, maybe you're onlytaking half a percent, 1%, 1.5%
from your portfolio.
That's going to be a very highprobability of success because
there's very littlecircumstances where that
withdrawal rate in fact maybe nohistorical circumstances where
that level of withdrawal ratewould deplete a normal portfolio
(09:01):
, a well-diversified portfolio,over a normal retirement horizon
.
So that might seem comfortingto look at that and say I've got
a 100% probability of success.
Until you recognize, or untilyou translate, what does that
actually mean?
No-transcript, so translatethat even further.
What does that mean?
It means you probably said noto a lot of fun, meaningful,
(09:24):
purposeful things that you couldhave done.
If our success is defined asmoney at the end of the day,
then 100% probability of success, that's tremendous success.
When you're looking at itthrough the lens of a Monte
Carlo analysis, when you'relooking at it through the lens
of how can we get the most outof life with our money, that
might be a definition of failure.
In many cases it might mean yousat around doing nothing
(09:46):
because you were too afraid totake that trip with your family.
You were too afraid to spend onthings that were meaningful to
you.
You didn't get around to givingyour money to family or causes
that you cared about.
There's so many things youcould have done, but maybe it
was fear-driven, maybe it wasbeing so focused on this
probability of success numberthat you end up letting the
things that are actuallymeaningful pass you by so that
you could chase this arbitraryand maybe ill-defined version of
(10:08):
success, which is this highprobability of never running out
of money.
That's not to say we want toflirt with disaster here.
It's not to say you should livelife on the edge and spend like
crazy and maybe you make it.
Maybe you don't.
What it is saying is thatoftentimes the plans I see where
there's 100% probabilitysuccess either means you have
such a large portfolio thatyou're fully living your life
(10:28):
and you're still going to havesome leftover, or it means
you're too afraid or toocautious to spend money on the
things that you care about andyou're going to end up looking
back on your life filled withregret because you see a really
high portfolio balance but whenyou're in your 80s and 90s and
looking back on your life, isthat what's going to be bringing
you joy?
Or instead are you going tolook back and say what, if what,
(10:48):
could I have done?
How do I use this money in away that was aligned with my
values and the things I enjoydoing?
So I wanted to take a quicksegue and discuss that, because
when 100% probability of successlooks good, feels comforting,
you're going to walk out of youradvisor's office feeling really
good about what you're doing.
But I might ask you to doublecheck that and to really think
through the implications of whatthat's really looking at.
Now let's go back to thequestion of what probability of
(11:10):
success is acceptable.
What number should I be lookingfor as I go through this, and
let's use an arbitrary example.
Let's assume you run yourprojections and you have an 80%
probability of success.
What we really interpret thatas if I'm running my plan and
that's my probability of success, I'm looking at that and saying
that's telling me I have a 20%probability of failure and, of
course, if I'm going to get onan airplane and go to a
(11:31):
destination, if there's a 20%chance that plane fails, I'm not
going to get on an airplane.
Those just aren't odds.
That's not a risk that in anyway I'd be willing, or any of us
would be willing, to take, andthat's how we interpret this.
Here's the difference, though.
If you create a plan at thevery beginning of your
retirement and if it says, forexample, you have an 80%
probability of success and ifyou never change your spending
(11:54):
patterns, you never revisit yourplan, you never change anything
about this for the rest of yourretirement, then you truly do
have a 20% chance of failing, ofrunning out of money before you
run out of life.
However, most people, I hope,aren't doing it that way.
Most people aren't creating aone-time plan and then never
looking at it again.
The reality is, you're notgoing to go from an 80%
(12:14):
probability of success today andthen tomorrow you wake up and
find that you've run out ofmoney.
What's going to happen is that80% is going to turn to 75.
It's going to turn to 72.
It's going to turn to 71, to 70, to 65.
It's going to be a gradual,slow burn and what you can do is
, if you're looking at this andmonitoring this regularly, you
can make course correctionsalong the way.
So, assuming you're willing tomake some of those adjustments a
(12:36):
20% probability of failure oran 80% probability of success
the way you should reallyinterpret that is there's a good
chance, there's a 20% chanceyou're going to need to make
some adjustment along the way.
For example, the market drops35% in your six of retirement.
Well, in your six of retirement, you're planning to buy a new
car and you're planning to takea great trip with your family.
Do you, for example, say I'mgoing to push this off?
(12:58):
I'm not going to buy the newcar until the market's recovered
.
I'm going to take a little tripthis year and push this bigger
trip off a year or two oncethings have recovered.
That's a great example of howyou can make some changes that
immediately will help toincrease the confidence of your
plan, the confidence level andthe probability of success.
Or maybe you're early on inretirement, you retire and you
retire, let's say, at 62.
(13:19):
In one year, in two years, inthe market's been horrible,
inflation's been horrible.
Inflation's been horrible andyou say you know I'm going to
get a part-time job for a coupleof years because that part-time
job is going to create moreincome that alleviates some of
the pressure on my portfolio.
Or maybe start social securityearly.
This is something not enoughpeople think about.
Sometimes people think I'mgoing to do social security at
70 and I'm going to retire at 65, for example, and their debt
(13:41):
set on.
Well, that could be a greatthing when you just look at it
in the grand scheme of things.
But one thing about socialsecurity you can view that in a
more dynamic way, where maybeyou retire at 65, but by 67,
you've had two really bad yearsin the market in a row.
Do you take social securityearly?
Because what that's doing isit's alleviating the pressure in
your portfolio, so you're notsimultaneously drawing down your
(14:03):
portfolio while also the marketis dropping your portfolio
value year after year.
So obviously, look at thesethings in context, look at these
things unique to your plan, butthese are the examples of types
of things that you can do sothat that 20% probability of
failure what that really shouldmean is there's a 20% chance you
need to be ready to make somechange like this in order to
preserve your portfolio for therest of your retirement years.
(14:25):
So, as you're thinking aboutthis for your plan, a big part
of this is going to come down tohow much margin do you have.
If you're in retirement andyour bare minimum essentials are
$4,000 per month and you haveincome of exactly $4,000 per
month, you don't really havemuch room to cut.
You don't have much margin tocut.
So you're going to need to havea higher probability of success
here, because it's not assimple as saying I'll push off
the new car purchase, I'll pushoff the big vacation, I'll push
(14:48):
off some of the discretionaryexpenses.
You don't have those to startwith in your plans.
There's nothing you can cut.
Versus those of you who youlook at your retirement budget
and you say, yeah, we don't wantto make cuts here, but we're
certainly willing to, becausemaking cuts for a year or so is
way better than running out ofmoney before you run out of life
.
Those of you that do havemargin, it would be easier to
make these cuts.
Therefore, you don't need ashigh of a probability of success
(15:11):
going into retirement becauseyou have the flexibility to make
some of those tweaks andadjustments along the way.
So I hope that one of the themesso far here is there's not an
exact number, there's not auniversal number of.
You need an 85% probability ofsuccess or you need a 70%
probability of success.
A lot of softwares kind of usethose numbers Anything below 70,
they look at that number andit's in red.
(15:31):
Anything between 70 and 85,they look at that number, it's
in yellow.
Anything 85 and above and it'sin green.
That's not true.
Maybe it's a great startingpoint.
It's really just somethingbecause we want to grasp to
certainty.
We want to have some level ofcontrol or certainty over what's
to come.
The unfortunate reality is wejust can't but understanding how
these things and how thiscontext should help you
(15:52):
interpret that probability ofsuccess.
That is the best thing that youcan do from this is what level
are we comfortable with and dowe have a contingency plan?
Do we have a contingency planof what we can do to cut
expenses, of what we can do tocreate more income, what we can
do if and when the market drops,to prevent that 10% probability
of failure, that 20%, that 30%,whatever it is, do we have a
(16:13):
plan in place so that, whenthose types of things happen
we've thought about it ahead oftime we can simply make the
changes that are needed to makesure that our portfolio value is
being preserved over theduration of our retirement?
Then the last thing that I wantto point out is sometimes these
Monte Carlo simulations arebased upon assumptions about
spending and simply extrapolatethat spending out into the
future.
Not a bad place to start.
(16:35):
But, for example, if I'm goingto illustrate $100,000 per year
of living expenses today and ifI'm going to assume an inflation
rate of 3%, what that means isI'm going to model out $100,000
this year of living expenses,next year it's going to be
$103,000.
The following year it's goingto be $106,000 and some change
and so on and so forth, as wecontinue to increase spending to
(16:55):
keep up with inflation.
Now, at first glance, we shouldbe doing that.
We want to preserve ourpurchasing power, not just that
strict $100,000 every singleyear, because if we never give
ourselves raises, inflation isgoing to go up, but our spending
is not and therefore ourstandard of living is actually
going to slowly decline.
Well, here's the thing aboutspending in retirement it
doesn't tend to actually keep upwith inflation.
(17:16):
There's a lot of great researcharound this and you've maybe
heard people talk about or metalk about the retirement
spending smile and talks aboutspending patterns of retirees.
But before I go, imagine youretire at 60.
What are you doing?
Imagine your lifestyle, thetrips you're going to take, the
activities you're going to do,the people you're going to spend
time with.
Just get a picture of what thatmight look like for you.
Now imagine what life lookslike for you at age 85, 25 years
(17:42):
into retirement.
Does it look the same?
Are you taking the same trips?
Are you involved in the sameactivities?
Are you as active?
Are you doing the same things?
The answer for most of youprobably is no, and I think when
you look at the research, itconfirms that.
Whereas if you look at retireesand if you look at a number
like $100,000 as a startingvalue not saying that's going to
be your number your number isprobably going to be different
(18:02):
than that, but if we use$100,000 as a standard research
shows the average realexpenditures.
So meaning what you spend butadjusted for inflation, drops by
about 25% by the time that youare 84 years old.
That doesn't mean that you'retaking pay cuts because you have
to.
It simply means you startslowing down.
It simply means all those tripsyou're taking earlier on in
(18:24):
retirement you're not takinglater in retirement.
So this is really important toknow because on average, your
spending is actually decreasingfor the first several years and
a couple of decades.
Even retirement beyond mid 80sand beyond it actually starts to
tick up.
That's simply due to medicalexpenses on average increasing
at that point.
So when you look at thisresearch again, we even have to
put this in proper context.
This is average spending.
(18:45):
Not all of us are average.
What this means is some of usare going to spend more, some of
us are going to spend less, buton average, real expenditures
do tend to drop for mostretirees over the first couple
of decades or so of theirretirement.
This is called the retirementspending smile because, if you
can envision it, spending startsrelatively high, it then starts
to dip in the middle and itstarts to increase again on the
(19:05):
back end, largely driven bymedical expenses One relatively
simple way to think about it,and this isn't precisely right,
but it's directionally correct.
If inflation increases by 3%,on average, retirees
expenditures are going toincrease by 2%.
So you're not taking dramaticcuts any given year, but on
average you're just not givingyourself a full cost of living
adjustment because you tend toslow down slowly but surely over
(19:27):
time.
Now this might not seem like ahuge deal.
While I was prepping for thisepisode, I went into our
planning software and I chose afew clients at random and I
simply looked at what is theirprobability of success as things
stand today, and then Icompared that to what would
their probability of success doif, instead of illustrating or
instead of modeling inflation,adjusted spending meaning
they're spending in retirementevery single year keeps up with
(19:47):
inflation?
What if we modeled out thisretirement spending smile,
meaning spending actuallydeclines a little bit over time,
based upon research done to seehow do retirees as a whole
spend, and on average, thatincreased their probability of
success anywhere between 5% and14% when I did this.
So that's in no way anindication that will do the same
(20:07):
for everyone.
I chose three people just outof curiosity, to say, if I just
toggle this on what's the changefor these specific clients.
But what does that mean?
It means those of you who areat 70% might not be unrealistic
to think if you actually spentthe way that most retirees spend
, that 70% turns to 78% or 79%.
That's a pretty dramaticincrease.
(20:28):
It might mean that if you're at85%, you're now in the low 90s
when you actually model out theway that real people spend their
real dollars in retirement.
So big, big, big disclosure herethis is not me doing research
with thousands of differenthouseholds.
That was literally pickingthree clients at random here at
Root Financial and just togglingsomething on for the sake of
this research that I was doingfor this episode, just to see
(20:50):
for those three what was theimpact.
Now, it might not be as high.
It probably won't be as highfor many of you.
For others it might be evenhigher.
So in no way take this as adefinitive, research-based thing
where you're going to get 5%,10%, 15% extra to your
probability of success.
That's not going to be the case.
All I do in saying this is Iwant to illustrate the fact that
you need context when you seethat Monte Carlo number.
(21:13):
That can either be reallyreassuring, sometimes in the
wrong ways or it can be reallyintimidating many times in the
wrong ways.
I'll go back to the individual Iwas talking to at the gym.
He made a dramatic, radicallife decision to say I'm going
to be working another 10 yearsbecause my Monte Carlo
probability of success droppedfrom almost 100% to 70.
I don't know all the details,like I said, of his plan, but
(21:34):
I'd be willing to guess that, ifyou factor some of these things
in of, what if you looked atusing your home as a plan B if
things didn't go according toplan?
What if you looked at spendinglike this, retirement spending,
smile.
What if you looked at otherthings?
Maybe it's a part-time work fora number of years?
What if you looked at the factthat you don't need a 99% 100%
probability of success?
But what is that number thatwe're comfortable with?
(21:56):
When we look at severity offailure, when we look at other
options that you have, it mightseem like, oh, james, this is
just splitting hairs, but it'snot, because when I go back to
this individual, it's notsplitting hairs to say that this
was the difference between 10more years of work when this
individual is ready to retireand start doing what he wanted
to do in retirement.
So, as we wrap up, I do want toreaffirm the fact that Monte
(22:17):
Carlo simulations can beincredibly helpful, but only
when viewed in the propercontext.
What you need to understand isthe way that those define
success and failure is notnecessarily the way I would
define success and failure.
One is looking at a very binarydecision of pass or fail.
The other is looking at whatdoes a life well-lived look like
?
How can we use your resourcesto do what you want to do?
(22:39):
And, as planners, instead ofmodeling something out today and
saying we're never going tochange anything for the next 30
years, what are the things wecan do along the way?
Maybe your probability ofsuccess isn't 100% In fact, I
hope it's not but what are thethings that we can do?
So we have contingencies inplace so that when things don't
go according to plan, whenthere's bad markets, when
inflation is out of control,when these things happen that we
(22:59):
don't want to happen, it's notgoing to derail our retirement,
because we've planned for thisin advance and we have things
that we can do.
So use the Monte Carlosimulation simulation absolutely
use it as part of your planningprocess, but understand how
that fits.
In the grand scheme of things,root Financial has not provided
any compensation for and has notinfluenced the content of any
testimonials and endorsementsshown.
(23:21):
Any testimonials andendorsements shown have been
invited, have been shared witheach individual's permission and
are not necessarilyrepresentative of the experience
of other clients.
To our knowledge, no otherconflicts of interest exist
regarding these testimonials andendorsements.
Hey everyone, it's me again forthe disclaimer.
Please be smart about this.
Before doing anything, pleasebe sure to consult with your tax
planner or financial planner.
Nothing in this podcast shouldbe construed as investment, tax,
(23:43):
legal or other financial advice.
It is for informationalpurposes only.
Thank you for listening toanother episode of the Ready for
Retirement podcast.
If you want to see how RootFinancial can help you implement
the techniques I discussed inthis podcast, then go to
rootfinancialpartnerscom andclick start here, where you can
schedule a call with one of ouradvisors.
We work with clients all overthe country and we love the
(24:06):
opportunity to speak with youabout your goals and how we
might be able to help.
And please remember, nothing wediscuss in this podcast is
intended to serve as advice.
You should always consult afinancial, legal or tax
professional who's familiar withyour unique circumstances
before making any financialdecisions.
This is another episode of Ready for Retirement.
I'm your host, james Canole,and I'm here to teach you how to
get the most out of life withyour money.
And now on to the episode.
I was at the gym the other dayand someone came up to me who
recognized me from the YouTubechannel and he said hey, I
watched some of your videos andwe got to talking and he was
sharing with me how he had saveda whole bunch.
He and his wife had saved.
(00:24):
They've done really well intheir retirement portfolio.
They had a paid off home herelocally in a very nice part of
town.
He had a pension from work, hehad social security and they
were planning to retire.
And he shared that they had a99% plus probability of success
as they modeled this out withtheir financial advisor.
Then he went on to share withme that he and his wife actually
just went through a divorce andafter the divorce, after
(00:48):
splitting assets, aftereverything settled, his Monte
Carlo probability of successdropped to about 70%.
Now this individual he was 60years old and he was planning to
retire very soon until thedivorce happened, until this new
financial model showed that hisprobability of success dropped
from almost 100% probability ofsuccess to 70% probability of
success.
He then went on to share thatbecause of this change to his
financial situation specificallythis change to his probability
(01:10):
of success, given Monte Carlosimulations his new plan wasn't
to retire soon, but was actuallyto work another 10 years until
the age of 70, at which time hewould max out social security
and his probability of successwould be right back up there in
the high 90%.
Now I don't know any of thespecifics of this individual
situation.
I don't know dollar amounts, Idon't know desired retirement
lifestyle, I don't know what hewants to do in retirement.
(01:32):
I know none of that information.
I don't even know whether hisdecision to continue working
longer or not was good or bad,because I just don't know enough
information.
But what struck me about thisconversation was how many
enormous life decisions weremade, at least seemingly,
because of this single number,this single probability of
success number called a MonteCarlo analysis.
(01:53):
So what I don't know is I don'tknow that him working 10 years
longer after this was the rightdecision or the wrong decision
in light of previouscircumstances and what he just
went through.
But what I do know is thatthere's some deeper questions I
would have wanted to unpack if Iwas his financial advisor, to
say how can we be sure thedecisions you're making because
of this aren't going to cost youlong-term?
How can we properly look atwhat that Monte Carlo
(02:15):
probability of success numberlooks like in the context of a
bigger plan, in some seeminglysmall details or nuances that
could have dramatic impacts onall of this?
So what we're going to do todayis we're going to talk about
defining what exactly is thatMonte Carlo number and then how
should we view it?
And not just how should we viewit, but what are some common
things I see that can radicallychange that number upwards or
downwards that you all should beaware of.
(02:37):
So, as you're running yourplanning projections, you're
viewing things in the propercontext and you're not letting a
single number drive thedecisions you make or don't make
when it comes to something asimportant as when you retire and
what you do in your retirement.
I'm going to start by definingwhat exactly a Monte Carlo
number is, what that probabilityof success number means.
So when you have this number,this probability of success, it
(02:58):
is a randomly generatedsimulation using various
investment returns, inflationreturns, life expectancy numbers
.
All these things we cannotperfectly predict in advance
what the market's going to do,what inflation is going to do,
how long we're going to live.
And so when you randomlygenerate a whole bunch of
different scenarios, sayingbased upon the return
characteristics and the riskcharacteristics, something
(03:19):
called standard deviation ofinvestment returns, for example,
we can have a wide outcome interms of the possible scenarios
that we go through when weretire.
So it's not enough just to saywhat if you average a certain
rate of return throughoutretirement.
We need to know the sequence ofthose returns.
How would our probability ofsuccess change if we go into
retirement and have really pooryears the first few years versus
having really good years in themarket for those first few
(03:41):
years?
So this is a gauge that helpsus understand what is the
probability of success, akawhat's the probability of me
achieving my goals throughoutretirement.
Now that's the next thing that'simportant to know how do we
define success versus failure inthis?
This is really important andwhile it might seem simple
enough, I'm going to show you injust a bit some of the
downsides of viewing retirementthrough this lens.
(04:02):
But success simply means youhave lived your whole retirement
and you still have assets inyour portfolio or in the bank
when you die.
That's success.
You don't run out of money.
Failure, as defined by thesesimulations, is you run out of
money before you pass away.
So, very simple, very binary.
Those are the two definitionswe're looking at, and the
probability of success sayswhat's the probability that
(04:23):
you're going to have more moneyin your portfolio when you pass
away, versus the probability offailure is, of course, what's
the probability that you'regoing to run out of money, based
upon these simulations.
So let's now dive into it.
And again, I don't know thespecific numbers for this
individual, so this is notdesigned to be a specific
recommendation, of course, tohis plan, as much as pulling out
the principles that all of uscan be aware of when it comes to
our own planning.
Number one, and the first thingthat I want to point out, is
(04:45):
you do not need 99% or even 100%probability of success in order
to comfortably retire.
So what number is acceptable?
Well, this is where it depends,and what it depends upon is it
depends upon what is calledseverity of failure.
So, for example, thisindividual I was talking to I
don't know the numbers, but hementioned he has social security
and he has a pension.
(05:06):
Let me just assume somearbitrary numbers.
Let's assume that he wants tospend $10,000 per month in
retirement and let's also assumethat between social security
and his pension he has $9,000per month coming in, meaning his
portfolio is responsible forthe extra $1,000 per month.
Well, severity of failure heremeans what happens in some of
those instances that he does runout of money.
The severity of failure is notthat bad.
(05:28):
He takes a 10% pay cut.
Instead of spending $10,000 permonth, he's spending $9,000 per
month.
Not ideal, but if that's worstcase scenario, I'd be willing to
venture that most people wouldbe okay with that as their worst
case scenario.
Now let's compare that toanother scenario.
What if that pension and socialsecurity added up to $3,000 per
month and he wanted or neededto spend $10,000?
(05:49):
Well, now the severity offailure is a whole lot different
.
He has to take a 70% pay cut,goes from $10,000 per month of
living expenses down to $3,000.
So that's one thing that youneed to know.
To put this in proper context,it's not just what's the
probability of success, butwhat's the severity of failure.
If your severity of failure isnot that bad, you can afford to
(06:10):
go into retirement with a lowerprobability of success because
it's not going to be disaster,it's not going to be doom and
gloom if you actually were torun out of money, because you
have some other income sourcesthere to continue meeting your
needs, if your severity offailure is high, meaning you
could not continue living if youran out of money.
That's where you're going towant to have a higher
probability of success beforeyou go into your retirement
(06:31):
decisions.
Another thing that you want tolook at is, in this case I don't
know the value of thisindividual's home, but I know
where his home is and I knowthose homes are quite valuable,
quite nice.
So when you look at that,typically when you're running a
Monte Carlo simulation, you'rerunning a simulation that says
can these assets, can theseportfolio assets, last forever?
Because these portfolio assetsare my means of creating income.
(06:52):
And when I say last forever,what I should have said is can
these last for the rest of mylifetime?
Well, if you run out of moneyin your portfolio but you still
have a home, a lot of theseMonte Carlo simulations will
show that that's a failure, andit very well could be.
But you have to ask what areyou going to do with that home.
Let's assume that you'relooking at your plan and you
have a $2 million home, so anice home, well-valued home
today, and you don't intend toever sell your home if you don't
(07:14):
have to.
But we somehow fast forward 25years.
You're 60 today and at age 85,we know that you ran out of
money, because we have theability to predict the future.
Well, that $2 million home, ifit's been appreciating by 4% per
year, that $2 million home isworth closer to 5.3 million by
the time that you're 85.
So the Monte Carlo simulationwould say that's a failure
(07:36):
because it fails to recognizethat you've got a significant
piece of equity being your homeand now, no, you can't spend
your home.
But could you take a reversemortgage?
Could you downsize?
Could you do something elsewith it that allows you to
continue generating incomethroughout the remainder of your
plan?
So these are some things tolook at.
What's the severity of failureif you do in fact fail?
What other fallbacks do youhave if you do in fact quote,
(07:59):
unquote fail, given yourportfolio runs out, your home
could certainly be somethingthere.
I'm going to come back to thispoint in just a little bit, but
the next point that I want tomake is a 100% probability of
success, in my opinion,oftentimes is not actually
success.
This goes back to defining atthe very beginning what I talked
about.
If success means you have moneyin your portfolio when you die,
(08:19):
failure means you run out ofmoney before you die.
It's as simple as that.
To have a 100% probability ofsuccess in most cases means you
have such a significant buffer,you have such a significant
margin that no market downturn,no level of inflation, no,
anything has a serious chance ofderailing your ability to spend
what you want to spend.
(08:39):
Oftentimes you could translatethat to meaning you're only
taking a very small amount outof your portfolio.
For example, maybe you're onlytaking half a percent, 1%, 1.5%
from your portfolio.
That's going to be a very highprobability of success because
there's very littlecircumstances where that
withdrawal rate in fact maybe nohistorical circumstances where
that level of withdrawal ratewould deplete a normal portfolio
(09:01):
, a well-diversified portfolio,over a normal retirement horizon
.
So that might seem comfortingto look at that and say I've got
a 100% probability of success.
Until you recognize, or untilyou translate, what does that
actually mean?
No-transcript, so translatethat even further.
What does that mean?
It means you probably said noto a lot of fun, meaningful,
(09:24):
purposeful things that you couldhave done.
If our success is defined asmoney at the end of the day,
then 100% probability of success, that's tremendous success.
When you're looking at itthrough the lens of a Monte
Carlo analysis, when you'relooking at it through the lens
of how can we get the most outof life with our money, that
might be a definition of failure.
In many cases it might mean yousat around doing nothing
(09:46):
because you were too afraid totake that trip with your family.
You were too afraid to spend onthings that were meaningful to
you.
You didn't get around to givingyour money to family or causes
that you cared about.
There's so many things youcould have done, but maybe it
was fear-driven, maybe it wasbeing so focused on this
probability of success numberthat you end up letting the
things that are actuallymeaningful pass you by so that
you could chase this arbitraryand maybe ill-defined version of
(10:08):
success, which is this highprobability of never running out
of money.
That's not to say we want toflirt with disaster here.
It's not to say you should livelife on the edge and spend like
crazy and maybe you make it.
Maybe you don't.
What it is saying is thatoftentimes the plans I see where
there's 100% probabilitysuccess either means you have
such a large portfolio thatyou're fully living your life
(10:28):
and you're still going to havesome leftover, or it means
you're too afraid or toocautious to spend money on the
things that you care about andyou're going to end up looking
back on your life filled withregret because you see a really
high portfolio balance but whenyou're in your 80s and 90s and
looking back on your life, isthat what's going to be bringing
you joy?
Or instead are you going tolook back and say what, if what,
(10:48):
could I have done?
How do I use this money in away that was aligned with my
values and the things I enjoydoing?
So I wanted to take a quicksegue and discuss that, because
when 100% probability of successlooks good, feels comforting,
you're going to walk out of youradvisor's office feeling really
good about what you're doing.
But I might ask you to doublecheck that and to really think
through the implications of whatthat's really looking at.
Now let's go back to thequestion of what probability of
(11:10):
success is acceptable.
What number should I be lookingfor as I go through this, and
let's use an arbitrary example.
Let's assume you run yourprojections and you have an 80%
probability of success.
What we really interpret thatas if I'm running my plan and
that's my probability of success, I'm looking at that and saying
that's telling me I have a 20%probability of failure and, of
course, if I'm going to get onan airplane and go to a
(11:31):
destination, if there's a 20%chance that plane fails, I'm not
going to get on an airplane.
Those just aren't odds.
That's not a risk that in anyway I'd be willing, or any of us
would be willing, to take, andthat's how we interpret this.
Here's the difference, though.
If you create a plan at thevery beginning of your
retirement and if it says, forexample, you have an 80%
probability of success and ifyou never change your spending
(11:54):
patterns, you never revisit yourplan, you never change anything
about this for the rest of yourretirement, then you truly do
have a 20% chance of failing, ofrunning out of money before you
run out of life.
However, most people, I hope,aren't doing it that way.
Most people aren't creating aone-time plan and then never
looking at it again.
The reality is, you're notgoing to go from an 80%
(12:14):
probability of success today andthen tomorrow you wake up and
find that you've run out ofmoney.
What's going to happen is that80% is going to turn to 75.
It's going to turn to 72.
It's going to turn to 71, to 70, to 65.
It's going to be a gradual,slow burn and what you can do is
, if you're looking at this andmonitoring this regularly, you
can make course correctionsalong the way.
So, assuming you're willing tomake some of those adjustments a
(12:36):
20% probability of failure oran 80% probability of success
the way you should reallyinterpret that is there's a good
chance, there's a 20% chanceyou're going to need to make
some adjustment along the way.
For example, the market drops35% in your six of retirement.
Well, in your six of retirement, you're planning to buy a new
car and you're planning to takea great trip with your family.
Do you, for example, say I'mgoing to push this off?
(12:58):
I'm not going to buy the newcar until the market's recovered
.
I'm going to take a little tripthis year and push this bigger
trip off a year or two oncethings have recovered.
That's a great example of howyou can make some changes that
immediately will help toincrease the confidence of your
plan, the confidence level andthe probability of success.
Or maybe you're early on inretirement, you retire and you
retire, let's say, at 62.
(13:19):
In one year, in two years, inthe market's been horrible,
inflation's been horrible.
Inflation's been horrible andyou say you know I'm going to
get a part-time job for a coupleof years because that part-time
job is going to create moreincome that alleviates some of
the pressure on my portfolio.
Or maybe start social securityearly.
This is something not enoughpeople think about.
Sometimes people think I'mgoing to do social security at
70 and I'm going to retire at 65, for example, and their debt
(13:41):
set on.
Well, that could be a greatthing when you just look at it
in the grand scheme of things.
But one thing about socialsecurity you can view that in a
more dynamic way, where maybeyou retire at 65, but by 67,
you've had two really bad yearsin the market in a row.
Do you take social securityearly?
Because what that's doing isit's alleviating the pressure in
your portfolio, so you're notsimultaneously drawing down your
(14:03):
portfolio while also the marketis dropping your portfolio
value year after year.
So obviously, look at thesethings in context, look at these
things unique to your plan, butthese are the examples of types
of things that you can do sothat that 20% probability of
failure what that really shouldmean is there's a 20% chance you
need to be ready to make somechange like this in order to
preserve your portfolio for therest of your retirement years.
(14:25):
So, as you're thinking aboutthis for your plan, a big part
of this is going to come down tohow much margin do you have.
If you're in retirement andyour bare minimum essentials are
$4,000 per month and you haveincome of exactly $4,000 per
month, you don't really havemuch room to cut.
You don't have much margin tocut.
So you're going to need to havea higher probability of success
here, because it's not assimple as saying I'll push off
the new car purchase, I'll pushoff the big vacation, I'll push
(14:48):
off some of the discretionaryexpenses.
You don't have those to startwith in your plans.
There's nothing you can cut.
Versus those of you who youlook at your retirement budget
and you say, yeah, we don't wantto make cuts here, but we're
certainly willing to, becausemaking cuts for a year or so is
way better than running out ofmoney before you run out of life
.
Those of you that do havemargin, it would be easier to
make these cuts.
Therefore, you don't need ashigh of a probability of success
(15:11):
going into retirement becauseyou have the flexibility to make
some of those tweaks andadjustments along the way.
So I hope that one of the themesso far here is there's not an
exact number, there's not auniversal number of.
You need an 85% probability ofsuccess or you need a 70%
probability of success.
A lot of softwares kind of usethose numbers Anything below 70,
they look at that number andit's in red.
(15:31):
Anything between 70 and 85,they look at that number, it's
in yellow.
Anything 85 and above and it'sin green.
That's not true.
Maybe it's a great startingpoint.
It's really just somethingbecause we want to grasp to
certainty.
We want to have some level ofcontrol or certainty over what's
to come.
The unfortunate reality is wejust can't but understanding how
these things and how thiscontext should help you
(15:52):
interpret that probability ofsuccess.
That is the best thing that youcan do from this is what level
are we comfortable with and dowe have a contingency plan?
Do we have a contingency planof what we can do to cut
expenses, of what we can do tocreate more income, what we can
do if and when the market drops,to prevent that 10% probability
of failure, that 20%, that 30%,whatever it is, do we have a
(16:13):
plan in place so that, whenthose types of things happen
we've thought about it ahead oftime we can simply make the
changes that are needed to makesure that our portfolio value is
being preserved over theduration of our retirement?
Then the last thing that I wantto point out is sometimes these
Monte Carlo simulations arebased upon assumptions about
spending and simply extrapolatethat spending out into the
future.
Not a bad place to start.
(16:35):
But, for example, if I'm goingto illustrate $100,000 per year
of living expenses today and ifI'm going to assume an inflation
rate of 3%, what that means isI'm going to model out $100,000
this year of living expenses,next year it's going to be
$103,000.
The following year it's goingto be $106,000 and some change
and so on and so forth, as wecontinue to increase spending to
(16:55):
keep up with inflation.
Now, at first glance, we shouldbe doing that.
We want to preserve ourpurchasing power, not just that
strict $100,000 every singleyear, because if we never give
ourselves raises, inflation isgoing to go up, but our spending
is not and therefore ourstandard of living is actually
going to slowly decline.
Well, here's the thing aboutspending in retirement it
doesn't tend to actually keep upwith inflation.
(17:16):
There's a lot of great researcharound this and you've maybe
heard people talk about or metalk about the retirement
spending smile and talks aboutspending patterns of retirees.
But before I go, imagine youretire at 60.
What are you doing?
Imagine your lifestyle, thetrips you're going to take, the
activities you're going to do,the people you're going to spend
time with.
Just get a picture of what thatmight look like for you.
Now imagine what life lookslike for you at age 85, 25 years
(17:42):
into retirement.
Does it look the same?
Are you taking the same trips?
Are you involved in the sameactivities?
Are you as active?
Are you doing the same things?
The answer for most of youprobably is no, and I think when
you look at the research, itconfirms that.
Whereas if you look at retireesand if you look at a number
like $100,000 as a startingvalue not saying that's going to
be your number your number isprobably going to be different
(18:02):
than that, but if we use$100,000 as a standard research
shows the average realexpenditures.
So meaning what you spend butadjusted for inflation, drops by
about 25% by the time that youare 84 years old.
That doesn't mean that you'retaking pay cuts because you have
to.
It simply means you startslowing down.
It simply means all those tripsyou're taking earlier on in
(18:24):
retirement you're not takinglater in retirement.
So this is really important toknow because on average, your
spending is actually decreasingfor the first several years and
a couple of decades.
Even retirement beyond mid 80sand beyond it actually starts to
tick up.
That's simply due to medicalexpenses on average increasing
at that point.
So when you look at thisresearch again, we even have to
put this in proper context.
This is average spending.
(18:45):
Not all of us are average.
What this means is some of usare going to spend more, some of
us are going to spend less, buton average, real expenditures
do tend to drop for mostretirees over the first couple
of decades or so of theirretirement.
This is called the retirementspending smile because, if you
can envision it, spending startsrelatively high, it then starts
to dip in the middle and itstarts to increase again on the
(19:05):
back end, largely driven bymedical expenses One relatively
simple way to think about it,and this isn't precisely right,
but it's directionally correct.
If inflation increases by 3%,on average, retirees
expenditures are going toincrease by 2%.
So you're not taking dramaticcuts any given year, but on
average you're just not givingyourself a full cost of living
adjustment because you tend toslow down slowly but surely over
(19:27):
time.
Now this might not seem like ahuge deal.
While I was prepping for thisepisode, I went into our
planning software and I chose afew clients at random and I
simply looked at what is theirprobability of success as things
stand today, and then Icompared that to what would
their probability of success doif, instead of illustrating or
instead of modeling inflation,adjusted spending meaning
they're spending in retirementevery single year keeps up with
(19:47):
inflation?
What if we modeled out thisretirement spending smile,
meaning spending actuallydeclines a little bit over time,
based upon research done to seehow do retirees as a whole
spend, and on average, thatincreased their probability of
success anywhere between 5% and14% when I did this.
So that's in no way anindication that will do the same
(20:07):
for everyone.
I chose three people just outof curiosity, to say, if I just
toggle this on what's the changefor these specific clients.
But what does that mean?
It means those of you who areat 70% might not be unrealistic
to think if you actually spentthe way that most retirees spend
, that 70% turns to 78% or 79%.
That's a pretty dramaticincrease.
(20:28):
It might mean that if you're at85%, you're now in the low 90s
when you actually model out theway that real people spend their
real dollars in retirement.
So big, big, big disclosure herethis is not me doing research
with thousands of differenthouseholds.
That was literally pickingthree clients at random here at
Root Financial and just togglingsomething on for the sake of
this research that I was doingfor this episode, just to see
(20:50):
for those three what was theimpact.
Now, it might not be as high.
It probably won't be as highfor many of you.
For others it might be evenhigher.
So in no way take this as adefinitive, research-based thing
where you're going to get 5%,10%, 15% extra to your
probability of success.
That's not going to be the case.
All I do in saying this is Iwant to illustrate the fact that
you need context when you seethat Monte Carlo number.
(21:13):
That can either be reallyreassuring, sometimes in the
wrong ways or it can be reallyintimidating many times in the
wrong ways.
I'll go back to the individual Iwas talking to at the gym.
He made a dramatic, radicallife decision to say I'm going
to be working another 10 yearsbecause my Monte Carlo
probability of success droppedfrom almost 100% to 70.
I don't know all the details,like I said, of his plan, but
(21:34):
I'd be willing to guess that, ifyou factor some of these things
in of, what if you looked atusing your home as a plan B if
things didn't go according toplan?
What if you looked at spendinglike this, retirement spending,
smile.
What if you looked at otherthings?
Maybe it's a part-time work fora number of years?
What if you looked at the factthat you don't need a 99% 100%
probability of success?
But what is that number thatwe're comfortable with?
(21:56):
When we look at severity offailure, when we look at other
options that you have, it mightseem like, oh, james, this is
just splitting hairs, but it'snot, because when I go back to
this individual, it's notsplitting hairs to say that this
was the difference between 10more years of work when this
individual is ready to retireand start doing what he wanted
to do in retirement.
So, as we wrap up, I do want toreaffirm the fact that Monte
(22:17):
Carlo simulations can beincredibly helpful, but only
when viewed in the propercontext.
What you need to understand isthe way that those define
success and failure is notnecessarily the way I would
define success and failure.
One is looking at a very binarydecision of pass or fail.
The other is looking at whatdoes a life well-lived look like
?
How can we use your resourcesto do what you want to do?
(22:39):
And, as planners, instead ofmodeling something out today and
saying we're never going tochange anything for the next 30
years, what are the things wecan do along the way?
Maybe your probability ofsuccess isn't 100% In fact, I
hope it's not but what are thethings that we can do?
So we have contingencies inplace so that when things don't
go according to plan, whenthere's bad markets, when
inflation is out of control,when these things happen that we
(22:59):
don't want to happen, it's notgoing to derail our retirement,
because we've planned for thisin advance and we have things
that we can do.
So use the Monte Carlosimulation simulation absolutely
use it as part of your planningprocess, but understand how
that fits.
In the grand scheme of things,root Financial has not provided
any compensation for and has notinfluenced the content of any
testimonials and endorsementsshown.
(23:21):
Any testimonials andendorsements shown have been
invited, have been shared witheach individual's permission and
are not necessarilyrepresentative of the experience
of other clients.
To our knowledge, no otherconflicts of interest exist
regarding these testimonials andendorsements.
Hey everyone, it's me again forthe disclaimer.
Please be smart about this.
Before doing anything, pleasebe sure to consult with your tax
planner or financial planner.
Nothing in this podcast shouldbe construed as investment, tax,
(23:43):
legal or other financial advice.
It is for informationalpurposes only.
Thank you for listening toanother episode of the Ready for
Retirement podcast.
If you want to see how RootFinancial can help you implement
the techniques I discussed inthis podcast, then go to
rootfinancialpartnerscom andclick start here, where you can
schedule a call with one of ouradvisors.
We work with clients all overthe country and we love the
(24:06):
opportunity to speak with youabout your goals and how we
might be able to help.
And please remember, nothing wediscuss in this podcast is
intended to serve as advice.
You should always consult afinancial, legal or tax
professional who's familiar withyour unique circumstances
before making any financialdecisions.
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